Understanding FOMO and How to Use the FOMO Indicator

Fear of Missing Out (FOMO) is a powerful psychological force that can lead even the most seasoned investors to make costly mistakes. A striking example is Stanley Druckenmiller, a renowned investor who lost billions of dollars during the dot-com bubble due to FOMO. At the height of the market, he witnessed his colleagues making massive gains and, feeling the pressure, he jumped back into the market, only to regret it moments later. If someone of his caliber can succumb to FOMO, then it’s clear that this is a challenge that all investors face.

The Science Behind FOMO

FOMO is not just a fleeting emotional response; it is rooted in our biology. As John Coates, a former trader turned neuroscientist, explains in his book, our physiological responses that evolved to help us survive in the wild often lead us to make poor decisions in the stock market. This understanding prompted me to create an objective tool to mitigate the risks associated with FOMO.

The FOMO Indicator

The FOMO Indicator is designed to help investors assess when the market is experiencing extreme buying pressure, which can often lead to poorly timed trades. It measures the percentage of stocks in a given index—such as the NASDAQ—trading above their 5-day average. High readings (above 85%-90%) suggest extreme buying, while low readings (below 15%) indicate fear and selling pressure.

What makes this tool unique is its ability to measure impulse-driven market behavior. The short 5-day timeframe focuses on immediate buying or selling trends, offering a real-time snapshot of emotional decision-making. For example, when 93% of stocks are trading above their 5-day average, it’s a strong indicator that investors are reacting emotionally, succumbing to the market equivalent of peer pressure. Conversely, when 93% of stocks fall below their 5-day average, fear dominates, often creating opportunities for disciplined investors.

How to Use the FOMO Indicator

• Monitor Market Conditions: Use the FOMO Indicator to gauge market sentiment. When the indicator shows that a large percentage of stocks are above their 5-day average, consider whether it’s wise to enter new positions – specifically breakouts or above recent price highs.

• Adjust Portfolio Exposure: If the indicator signals extreme buying, it may be a good time to reassess your exposure levels. This helps prevent overexposure during market extremes, which can lead to significant losses if the market reverses.

• Analyze Individual Stocks: Apply the FOMO Indicator not just to the overall market but also to specific stocks or sectors. For example, if a tech stock shows high FOMO levels and you’re considering buying, think twice and evaluate if there’s a better entry point. Conversely, low FOMO readings can indicate a good opportunity to buy during a temporary dip.

Why This Indicator is Useful

The FOMO Indicator isn’t about predicting market perfection—it’s about offering an objective and visual reminder of short-term investor impulses. It acts as a reality check against our human tendencies to feel overly optimistic during market peaks or excessively negative after drops.

Examples of the FOMO Indicator in Action

Let’s look at a couple of examples to illustrate how the FOMO Indicator can be applied:

ServiceNow ($NOW) (General market flow)

ServiceNow (NOW) is a leading large-cap technology company that has delivered exceptional performance, trending strongly higher for months. However, it hasn't been immune to market swings. Most of NOW's peaks have aligned with periods of elevated general market FOMO, while its bottoms have often coincided with moments of short-term fear.

While these swings may seem minor compared to its overall uptrend, entering at a peak during heightened FOMO often leads to initial losses. These losses can be both costly and psychologically challenging, potentially prompting fear-driven selling at the worst time. Interestingly, most of NOW's short-term bottoms have occurred during broader market fear, highlighting the importance of timing and sentiment in managing positions effectively.

Upstart Holdings ($UPST)

Upstart Holdings is a prime example of a momentum-driven stock. As a company aiming to revolutionize the personal loan industry, it carries both significant potential and inherent uncertainty. This combination often fuels strong emotional reactions, which are reflected in its stock movements.

Notably, the stock's most significant peaks and bottoms have consistently aligned with periods of heightened FOMO and fear in the broader market, highlighting the emotional undercurrents driving its volatility.

Russell 200 Small Cap Index ($IWM)

While mega-cap stocks are not entirely immune to Fear or FOMO, these emotional swings are far more pronounced among smaller and mid-cap companies. Like Upstart, these companies face greater uncertainty about their future, which amplifies investor emotions and drives more dramatic stock price movements.

How Not to Use the FOMO Indicator

While the FOMO Indicator is a helpful tool, no tool is perfect, and context is always critical. Though FOMO and FEAR are important concepts, so are trend and stock leadership. Stocks with innovative products that capture the imagination of investors and change how we “live, work, or play” have the potential to advance far more than we might expect. Additionally, trying to sidestep a small pause in a stock may not be worth the risk of missing its upside potential.

Stock leadership is a core concept that I adhere to, and for this reason, I do my utmost to avoid selling my best-performing stocks during periods of FOMO. Instead, I reduce overall portfolio exposure by trimming lagging stocks. The irony of the market is that a lagging stock, which advances the least during a market uptrend, is likely to fall faster and further than a leading stock that has advanced rapidly.

In this current market cycle, PLTR has been a true leader. If you inspect the chart below, you will notice that market FOMO did little to slow the stock's powerful advance. The lost potential upside far outweighed the downside risk. Having actually held PLTR during this advance, I chose not to sell it during periods of FOMO. Instead, I used those opportunities to reduce risk by selling underperforming stocks. It is only logical that stocks underperforming during a strong market are likely to underperform even more if market tailwinds disappear. When studying this tool, always keep the context of the stock top of mind.

The Flip Side of FOMO: Harnessing FEAR for Opportunity

While FOMO can lead to overexposure during euphoric market conditions, its flip side—fear—can present unique opportunities for disciplined investors. Markets often swing between extremes, and when fear dominates, prices can drop to levels that offer a positively skewed reward-to-risk ratio. The FOMO Indicator isn't just a tool to avoid poor timing; it can also help you identify optimal entry points when fear creates short-term market inefficiencies due to panic.

In fact, fear is an even more powerful emotional driver than FOMO, and the most significant market bottoms often coincide with very low readings on the FOMO Indicator, signaling heightened fear – making this a very helpful tool at both market extremes.

Real-Life Example: Managing Fear with the FOMO Indicator

Nvidia ($NVDA) 2023-2024 AI Leader Building on the importance of context when evaluating FOMO and Fear, a more effective way to utilize the FOMO Indicator with leading stocks is to focus on buying during periods of Fear.

Unlike weaker stocks, a strong stock that resists falling during market weakness signals underlying demand. If the market recovers, such a stock is likely to rally even more robustly. For example, buying NVDA during moments of Fear in early 2023 aligned closely with its major bottoms, showcasing the power of this approach with true market leaders.

Conclusion

Managing emotions at market turning points is critical, and the FOMO Indicator is a key innovation we've developed at Caruso Insights to address this challenge. However, the true value lies in integrating this tool into a holistic investment process. Such a process helps investors capitalize on strong markets while mitigating losses in weaker ones. Drawing on 20 years of experience as a market maker, trend follower, and more, I've learned that a structured approach is essential for long-term success and adapting to ever-changing market dynamics.

For additional market education and more on investing strategies, visit Caruso Insights

.You can also watch the recent YouTube video on FOMO Indicator here

Matt Caruso is a market professional with unshakable optimism and an endless drive to succeed. He believes in continual growth and building a bright future with like-minded people. 

His professional experience as a market maker and teaching skills as a former finance professor has resulted in regular appearances in financial media such as Fox Business News, Investor’s Business Daily, and Business Insider. 

"Successful investing can be learned, but the greatest reward is the personal growth you experience along the journey."